Employment Status and the Personal Tax Consequences
Ravi has worked for Kestrel Media Ltd for 18 months as a 'freelance' video editor. He works five days a week, is paid a fixed monthly amount, must work set hours in the company's office, uses company equipment, cannot send a substitute, and takes holiday only when the company approves it. He invoices through his own personal service company (PSC), of which he is the sole director and shareholder, and pays himself a small salary plus dividends. HMRC has opened an enquiry into the PSC's contracts. Separately, Ravi received £2,000 of dividend income from an unrelated UK company in 2024/25 and is unsure how it is taxed.
1. Apply the tests relevant to employment status and advise on the likely outcome for the PSC engagement, explaining the consequence if HMRC succeeds.
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Apply the substance-over-form tests (the 'IR35' / off-payroll framework):
| Factor | Facts | Points to |
|---|---|---|
| Control | Set hours, set location, company directs work | Employment |
| Substitution | Cannot send a substitute | Employment |
| Mutuality of obligation | Fixed monthly pay, continuous 18 months | Employment |
| Integration | Works in office, uses company kit, holiday approved | Employment |
| Financial risk | No evidence of bearing risk or providing own equipment | Employment |
| Own account | Single client, no other customers | Employment |
Conclusion: on these facts the engagement looks like employment in substance. The PSC structure does not change the underlying relationship. Because the end client is a medium/large private-sector business (assumed), responsibility for determining status and operating PAYE sits with Kestrel Media, not the PSC - but if the client is small, the PSC remains responsible. The answer must flag this dependency rather than assume.
Consequences if HMRC succeeds: income tax and employee NICs due on the deemed employment income, plus employer NICs (and possibly apprenticeship levy), interest and penalties. The PSC's dividend extraction is recharacterised - the low salary/dividend split loses its advantage. Ravi should consider whether the contract can be redrafted to reflect genuine business-on-own-account terms (substitution clause, project-based fees, own equipment) - but only if that reflects reality; a paper change will not survive enquiry.
2. Explain how Ravi's £2,000 dividend from the unrelated company is taxed in 2024/25, and state what else you need to know.
Read the worked answer
Dividend taxation 2024/25: dividends are taxed as the top slice of income, after the personal allowance and other income, at 8.75% (basic rate band), 33.75% (higher rate) or 39.35% (additional rate). The dividend allowance is £500 - dividends within the allowance are taxed at 0% but still use up band width.
Calculation depends on Ravi's other income. If, say, his salary and other dividends already use his personal allowance and basic rate band, the £2,000 falls in the higher-rate band: £500 at 0% and £1,500 at 33.75% = £506.25. If he has little other income, part could fall in the basic rate band at 8.75%.
Information required: his total taxable income and how much of the basic and higher rate bands remain; whether the £2,000 is a genuine dividend (paid from post-tax profits, with proper board approval and dividend vouchers) or a disguised payment; and whether the dividend is from a company where he is a shareholder (affecting the £500 allowance usage but not the rate).
Common trap to flag: the £500 allowance is not a tax-free amount that can be ignored - it consumes band width, and the 0% rate is not the same as exemption. Also, the personal allowance tapers by £1 for every £2 of income above £100,000, which would change the marginal rate on the dividend if his income is near that threshold.